Journal of Islamic Accounting and Business Research

Emerald Article: The UK legal reforms on pension and the opportunity for Islamic pension funds Faizal Ahmad Manjoo

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Faizal Ahmad Manjoo, (2012),"The UK legal reforms on pension and the opportunity for Islamic pension funds", Journal of Islamic Accounting and Business Research, Vol. 3 Iss: 1 pp. 39 - 56 http://dx.doi.org/10.1108/17590811211216050 Faizal Ahmad Manjoo, (2012),"The UK legal reforms on pension and the opportunity for Islamic pension funds", Journal of Islamic Accounting and Business Research, Vol. 3 Iss: 1 pp. 39 - 56 http://dx.doi.org/10.1108/17590811211216050 Faizal Ahmad Manjoo, (2012),"The UK legal reforms on pension and the opportunity for Islamic pension funds", Journal of Islamic Accounting and Business Research, Vol. 3 Iss: 1 pp. 39 - 56 http://dx.doi.org/10.1108/17590811211216050

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The UK legal reforms on pension and the opportunity for Islamic pension funds
Faizal Ahmad Manjoo
Markeld Institute of Higher Education, Leicester, UK
Abstract
Purpose Recent developments in pension law in the UK has seen a shift towards the creation of a Shariah fund under the National Employment Savings Trust (NEST) to cater for British Muslims retirement needs. However, as the concept of funded pension is an alien concept in Islamic history, there is a need to analyse the intricacies associated with the establishment of such occupational pension plan. The purpose of this paper is rs, to address the concept of pension to see how it ts with Muslim ethos, and second, to highlight some Fiqhi (Islamic jurisprudence) issues that need to be addressed before establishing the Shariah pension fund. Design/methodology/approach The paper rst traces the historical development of pension in the UK and how the issue of an ageing population is shaping the reforms. It subsequently highlights some of the Fiqhi issues that need to be addressed in establishing the new Shariah fund and recommendations are then made. Findings The paper sheds some light on the need to consider the idea of savings in Islam to meet retirement needs because the societal structure of Muslim community in the UK is economically changing as compared to the past. Hence, the concept of pensions is seen to t into the maqasid of Shariah which includes protection of life, family and wealth. However, there are some haram (non permissible) elements, such as annuities and nominees (which affect the law of inheritance), that need to be eliminated in the legislation and pension models currently available. Hence, a model is suggested to help make the Shariah fund offered to British Muslims via NEST to be religious compliant. Practical implications The recommendations made in this paper will facilitate to some extent addressing some of the qhi issues to make the fund religiously suitable. Social implications To align an Islamic occupational pension model with that of its mainstream counterparts requires addressing some of the qhi issues to make the fund religiously suitable. Originality/value A modern Islamic occupational pension fund is a new phenomenon in the Muslim world, and this issue is hardly being addressed so far. This paper highlights some pertinent qhi issues to be considered in establishing such an occupational pension fund. Keywords Pensions, Ageing population, Pension legal reforms, Pension nds management, United Kingdom, Fiqh, Islamic nance Paper type Technical paper

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1. Introduction Pension, which was originally meant as a means to support those who were loyal to the state after their retirement, has now become a multibillion dollar business industry. Pension companies have spread their tentacles in various facets of world economies. The reason being that pension often constitutes the bulk of a persons savings which are invested in other nancial intermediaries. In fact, pension funds are giant investors in many economies. State pensions has been shrinking in governments budgets and there is a need to nd solutions to keep up with the consumption smoothing process, i.e. to help people

Journal of Islamic Accounting and Business Research Vol. 3 No. 1, 2012 pp. 39-56 q Emerald Group Publishing Limited 1759-0817 DOI 10.1108/17590811211216050

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maintain a reasonable standard of living after retirement. Hence, there has been a push towards personal savings which in turn increases the demand for private pension funds investment to provide good returns to mitigate the nancial expectation of pensioners. This is mainly manifesting in countries inicted with the ageing population phenomenon. The recent credit crunch is another factor that had signicant impact on many of the pension funds and triggered the need to revisit pension laws and policies in many countries. The above two factors generated a wave of legislative reforms in the UK, especially after the release of the Turners Report in 2006. The Report suggested a plan towards personal savings that will be channelled into a low-fee charge fund in order to cater mainly for those who have not been catered for their retirement. There were reforms to the Pension Act of 2007 as well. In this upheaval of pension reforms, it is noticed that Islamic pension has joined the ofcial discourse to meet the needs of British Muslims. The government created a legal body called the National Employment Savings Trust (NEST). NEST accommodates a Shariah fund, aiming at serving the British Muslim community. This paper aims to contribute to the legal aspect of pensions by examining legal reforms related to pensions in the UK in general, and to analyse qhi issues surrounding the establishment of the said Shariah fund. This is an important issue to address due to the increase in the ageing population and the drop in dependency ratio in the UK. The paper is structured as follows. Section 2 describes the evolution of conventional pension and NEST, a form of saving pension which will be effective from 2012 in the UK. This section highlights the conceptual evolution from a philanthropic approach towards a contractual approach in delivering pension services. Historically, the authority offered such service as a guarantee after retirement, but later shifted towards private and occupational pension. This changed the original concept of pension into a commercial venture which has contractual implications. An analysis of how the ageing population in the UK is contributing to further legal reform is also presented. Section 3 explores the concept of pension from an Islamic perspective and it is argued that modern day private and occupational pension did not exist in the past. Section 4 deals with the NEST Shariah fund and a qhi analysis is undertaken regarding this fund and the related investments issues in setting up the fund. Some recommendations are made to meet the social construct of British Muslims. 2. Evolution of conventional pensions 2.1 Historical analysis of the types of pension Pension is a stream of payments that starts when someone retires and continues to receive payments until death (Blake, 2006). This periodic money payment to a person who retires from employment is not necessarily because of age alone but also due to disability or the completion of an agreed span of service (Burlin et al., 2010). In practice, pension involves purchasing an annuity from an insurance company and this form of annuity provides a guaranteed income till death (Mayhew, 2001). It is interesting to note that the Pension Act 2004 (as amended) does not provide a denition for pension but from the various denitions available, one can gauge two important aspects that need addressing for an Islamic pension. The rst one is that there is a legal nexus between the providers and recipients of pensions, and second, there is an element of annuity.

Historically, the idea of pension emerged as an inducement device to attract or retain favoured or strategic servants. According to Blackburn (2002, p. 36), the rst pension can be traced to the Elizabeths Parliament for soldiers in 1598 but Blake (2003) argues that the rst occupational pension was for the customs ofcers in 1712. The characteristics of this original thought are that the authority guaranteed the strategic workers to continuous sum of money for their loyalty and there was no need to contribute to stipend after retirement. This was known as the puritan tradition of pension. Another tradition was that of the baroque tradition which focused on the universal, well-ordered public space and benecent, and sees the pastoral role of the state as an instrument of social harmony. Its roots are in absolutism and counter-reformation, offering the monarch and the Church formulas in re-establishing their authority and leadership by exalting them as instruments of Divine purpose (Blackburn, 2002). A seminal contribution introduced by Leopold von Bismarck in Prussia (Germany) was the Old Age and Disability Insurance Bill of 1889. It was equally nanced by employers and workers, designed to provide a pension annuity for workers who reached the age of 70 years. This can be considered as the rst step towards funded pension. However, over time, pension became a burden for the state and private pension was developed in the UK. With the growth of life assurance companies in the eighteenth century, actuarial calculation gain momentum which helped in creating the endowment-assurance pension schemes to enable individuals to save for their old age and provide some securities for their families. Many companies in the UK during the eighteenth to nineteenth centuries allowed their employees to make their own arrangements for better nancial provision besides their state pension (Blake, 2003). Though there was a need to universalize welfare, government budgets had its own constraints. In the interim, the private sector developed pension funds for its labour force. This brought in a new legal nexus because providing pension now became a business and was not based on service and loyalty as before. By 1921, two main types of pension funds were developed in the UK: the state and private pension funds. After the two World Wars, the existing pension funds underwent a lot of changes. Pension law was a bone of contention between the Labour and Conservative in the 1970s and 1980s (Blake, 2003, p. 33). Due to the instability in mortality rate and longevity risk that started in the 1980s, contributors now had to buy a pension plan based on dened contribution rather than dened benet (Granger, 2008). Under dened benet plan, contributors would pay a sum of money and would get a dened benet, i.e. they would know more or less how much they would receive as pension after their retirement. Thus, it became a contractual relationship between employers and employees. It also became a private affair rather than a state sponsored issue with employees still needing to pay the National Insurance from their salary in order to secure a minimum pension upon retirement. The problem is accentuated with the ageing British population and the state of the current economy. 2.2 The implications of the demographic change in the UK The fast ageing population has triggered a worldwide effort to reconsider pension law. The World Economic and Social Survey (UN, 2007) published the The Development in an Ageing World to help countries cope with it. As far as the UK is concerned, the ageing population phenomenon is having a direct impact on the governments budget and Lord Turners Report was mandated to survey this problem in 2004 (Controller of

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Her Majestys Stationery Ofce, 2004). According to the Turners Report, the long-term trend in old-age dependency ratio (dened on a static retirement age of 65) is steadily rising as a result of increasing life expectancy. As can be shown in Figure 1, for the last 30 years, the ratio has diverged increasingly below the long-term trend as a result of the expansion of the working age population which the baby boom of the 1940s to 1960s produced. But looking forward, the retirement of the baby boom generation (i.e. the delayed effect of the fall in fertility which occurred between the early 1960s and mid-1970s) will produce a rapid return to the trend line, with this effect being concentrated in the years 2010-2035 as reported by the Turners report (Controller of Her Majestys Stationery Ofce, 2004, p. 11). As a result, over the next 40 years, there will be an increase in average pensionable ages in proportion to rising life expectancy and this is not a sufcient response to the demographic challenge. It is expected that about 40 percent of the British population will be above 65 years of age by 2050. The impact of the ageing population is quite signicant in that it will change the market structure in the long run because the need of the elderly is not the same as that of the younger generation. Their need for clothing and food are different and they tend to stay more at home, implying more demand for electricity and gas (Thillainathan, 2000). Their medical needs are also more pressing, which in turn will affect the health budget and put pressure on the NHS. Hence, a radical revamp of the pension is badly needed. Following the Turners Report and recommendations, many legal reforms took place to mitigate the effect of the ageing population and the crisis of supporting them. 2.3 Legal reforms and NEST The Pension Act 2007 reformed the state pension and introduced arrangements to increase the state pension age. In the past, employees could retire as early as 55 years

Figure 1. Impact of the 1940s baby boom on the old age dependency ratio

Source: Pension Commissions (2004) analysis based on a synthetic model of the England and Wales population; contains Parliamentary information licensed under the Open Parliament Licence v1.0: www.parliament.uk/siteinformation/ copyright/open-parliamentlicence/

under certain circumstances though the norm was 60. This is understandable because in the 1950s, there were about seven tax payers to support an old person but the dependency ratio has now dropped to about 3.2 (Ofce of National Statistics, Pension Trends Chapter 2, 9 April 2010). The situation was made worse with the reduction in government budget following the credit crunch (PADA, 2009 Myth busters). In 2008, the Act introduced another reform at the work place which aims at encouraging people to save. This was a major step in the concept of pension as the state is now indirectly imposing (or encouraging) people to save and this changes the whole dynamics of pension. The legal nexus of pension is no more benevolent as it was in the seventeenth century, but instead it has become contractual and funded by the private sector. Due to the escalation in the governmental budgetary constraint in sustaining old citizens, it has become imperative for employees to cater partly for their old age themselves. It is estimated that seven million people in the UK will not have adequate means of sustenance when they reach 65 years old (NEST, Key facts and buster: 2011). Therefore, NEST has been established to take charge of pension issues. This is an automatic enrolment which will be effective as from 2012. The onus will be upon employers, who will have to automatically enrol all workers who are 22 years of age and 7,475 (NEST, Key facts and myth busters, 2010). who earn a minimum yearly income of E The employer will have to deduct 4 percent from the pay of the employee on a Pay as You Go basis. This means that the employee has the possibility to continue with his/her contribution even when he/she shifts job. The total minimum contribution to a workers retirement pot will be 8 percent of their qualifying earnings. Of this 8 percent, the employer will have to contribute a minimum of 3 percent. The rest will be made up of tax relief and the jobholders contribution (NEST, key facts and myth busters, 2010). The system aims to be a national, low charge workplace pension scheme. Besides being a semi-governmental body, NEST is unique in that this is the rst time that the possibility of establishing a Shariah fund to cater for the need of Muslims has been seriously considered. Thus, the prospects and challenges of managing such Shariah fund and the Islamic perspective of pension should be given due consideration. 3. The concept of pension in Islam 3.1 Historical analysis Pension, as we know it today, does not seem to have an Islamic parallel. Rather, there (sustenance) or wazifa (fees/stipend) that has its own particularity. was a system of ata Nevertheless, for the purpose of discussion, the term pension will be used. The rst recorded pension system in the Islamic world could be traced during the caliphate of Umar bin Khattab (d. 644 CE). He was known as the founder of the treasury system in the Islamic world. It is reported that Abu Hurairah, who was the governor of Bahrain, made a huge tax-collection which he then brought to Madinah, the capital of the Islamic world then. Upon the advice of Walid bin Hisham, a diwan (registry for the army) was drafted and from which the soldiers were classied and accordingly an annual allowance was allocated to them. However, other categories of beneciaries, such as orphans and wives of the Prophet Muhammad, were also allocated an annual allowance. There were also annual provisions for the soldiers wives and children (Numani, 1975). The expansion of Muslim lands by the conquest of Iraq, Syria, etc. provided a source of regular inow of money in Arabia. Umar divided ya ) and the other was a his pension into two types: one was an annual pension (ata

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q) (Zaman, 1991). He emphasised on the service to religion as the monthly ration (arza criteria to provide a pension for the soldiers, which is similar to the baroque system discussed earlier. There was also stipends given to orphans and wives of the Prophet and by analogical deduction, we can infer that some type of pension for the underprivileged or women was available from state pension. According to Baladhuri (1932), the ration system which consists mainly of provisions such as wheat, oil and vinegar is considered as a mechanism for pension in kind. Umar also catered for the awali, people residing in the suburban areas of Madinah. However, no specic allowance is recorded for them. It was mainly a pension in kind. During the caliphate of Uthman bin Affan, besides ration, clothing was added to the list (Zaman, 1991). The system established by Umar was enhanced by the other caliphs such as Ali and Muawiyah. Though pension was originally conned to those who participated in jihad (striving in the cause of Allah), it later shifted from pension to ration. Abu Ubaydha, the governor of Syria, did not give pensions from the fay money (booty received from the conquered people who submitted to the Muslim army) as he was worried that the fund will not sustain such governmental expenses (Zaman, 1991). From the previous Islamic pension systems, several inferences can be drawn. First, Islamic pension need not necessarily be in cash and it can be in kind such as ration, clothing, etc. Such pension funds, which are not based on money alone but also in kind, should be seriously considered to overcome volatility of the purchasing power of currencies. Second, there is a need for risk management of such a fund especially for the decumulation[1] phase of present day pension fund. Third, the policy of pension in the Islamic empire was decentralized, which has political and economic implication. Fourth, q (voluntary) sector, and an important well entrenched Islamic economic model is the infa l. The one of the pivotal vehicles to mobilize nancial resources is through the baitul ma l were not built on contract of support, but rather have its own funds from the baitul ma specicity with regard to the accumulation and decumulation of such fund as well as the criteria for the beneciaries. Although the rules are stringent, the model has the potential of being developed into an Islamic model for pension fund. From an Islamic perspective, the whole concept of retirement and savings for old age within certain legal and regulatory framework needs a fresh analysis. In the past, people would sustain themselves as long as they could and if they failed to do so, their children, extended families and communities would look after them. The Quranic injunction and prophetic traditions are clear regarding the respect and duty one owes to his or her parents (Quran, 17:23) and also the responsibility of the communities to help the needy. So, the family structure and law of maintenance were well established to protect the old. However, with the passage of time and changes in the family structure, the issues of q (voluntary sector) for the elderly nafaqah (maintenance and duty of support) and infa were neglected. There is an urgent need to pay due attention to this issue as there is no l nor well established awqaf (endowment) to sustain the elderly in most Muslim baitul ma societies today. With the concept of extended family slowly phasing out and the elderly having to cater for themselves, pension fund becomes an important source to support the needs for retirement. However, one wonders if this is indeed the Islamic solution? As society changes, there is a need to consider the prevailing urf (custom) to determine a better pension scheme. The need for such a move is due to some unIslamic elements in present day conventional pension fund such as the prohibited channels through which the fund is invested and the issuance of annuities which

reverts back to interest. The emergence of Islamic Banks, takaful companies and Shariah funds is an indication that the next stage of Islamic nance could well be q sector. Islamic pension fund and also the possibility of developing the infa 3.2 Pension need of Muslims in the UK The rapidly changing lifestyle with longer lifespan and extended families slowly disappearing, it would not be long that Muslims in the UK will need to cater for their old age on their own.[2] Although there is no real statistics focusing on the demand for pension by British Muslims, the demographic distribution in Figure 2 shows the potential situation on the demand. It can be shown in Figure 2 that 69 percent of UK Muslims are from the Indian Sub-continent with 31 percent from other parts of the world. The census ethnic category Black (6 percent) applies to Black Caribbean, Black African, and Other Black. The Other category (21 percent) includes Muslims of Arab, Turkish and Persian ethnicity. Although it is not clear from the above gures how many Muslims will need to be catered for pensions, Turners Report provides some benchmark in forecasting the need. Muslims in the UK constitutes about 2-3 percent of the total population. Assuming a statistical linearity between total population and Muslim population, then 7,475 and E 25,000 will need to be approximately 51 percent of those earning between E registered with a pension fund (PADA, 2009Myth busters). So far, there is no Islamic occupational pension fund in the UK. Consequently, those who have purchased any pension plan would do so from the conventional providers. This should be relatively a small number because Muslims in the UK are among the most affected by unemployment and not having disposable income to purchase personal pension. If previously it was not possible for Muslims in the UK to develop their own pension fund, the low wage earners will now have an opportunity to contribute in the NEST Shariah fund. 4. The NESTS Shariah fund 4.1 Introduction on NEST NEST is a low charged fees fund aimed at helping those at the bottom of society. The Shariah fund is perceived as being a useful saving plan for pension rather than a wealth creation tool. However, there are a number of issues that need due consideration.
Ethnic Categories of the 1.6 million British Muslims White Britsh 4% Bangladeshi 17% Black 6% Indian 9%

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Pakistani 43%

Other 21%

Source: www.salaam.co.uk, data from 2001 Census

Figure 2. British Muslim population by ethnic groups

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Since Shariah fund is separated from the default or main fund, it will incur extra costs such as consultancy costs associated with the Shariah supervisory board, increase investment cost due to lack of volume, and also the costs for extra software that is needed to monitor this specic fund and Islamic banking accounts, etc. It is submitted that the accumulation phase is going to be slow as there are not enough Muslims capable of contributing and also the negative attitude towards pension among the Bangladeshi and Pakistani community based on the results of a survey conducted in Oldham (Joseph Rowntree Foundation, 1999). Hence, developing the critical mass for the fund to sustain itself is of utmost importance. 4.2 Investment aspects for the Shariah fund The investment avenues identied by NEST are shown in Figure 3. From these avenues, only three areas can be potentially explored Islamically: equities, Islamic bonds (sukuk) and property. It is not clear from NEST regarding its investment policy on such funds. The rest of the products do not conform to Shariah and there is hardly any Islamic equivalent in the UK for such products as yet. However, there are other avenues that NEST can explore such as Islamic REITs, foreign exchange market and infrastructure nancing projects. The risk premia prole for investing in those avenues has been surveyed by NEST and is shown in Figure 4. A risk premium is the additional return over and above that provided by risk-free assets such as government bonds or cash, which investors

Figure 3. Recommended asset classes

Note: The figure chart shows the number of times each asset class has been mentioned by respondents Source: PADA (2009) Contains Parliamentary information licensed under the Open Parliament Licence v1.0: www.parliament.uk/site-information/copyright/ open-parliament-licence/

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Source: Pensions Commission (2004); Contains Parliamentary information licensed under the Open Parliament Licence v1.0: www.parliament.uk/site-information/copyright/openparliament-licence/

Figure 4. Illustrative risk premia for alternative asset classes (2009)

will be rewarded for bearing extra risk. The chart shows the various additional risk premia (over and above cash) present in a selection of asset classes. For example, the chart illustrates that investors in private equity can expect to receive the highest premium due to that assets exposure to equity and illiquidity risks. Even if the Shariah fund invests in equity, there will be two levels of ltering to perform: qualitative and quantitative. As far as the quantitative aspect is concerned, these are relatively straight forward, i.e. if the core business of the listed company is prohibited, then such company should not be considered for investment. However, different Islamic indices have adopted different types of companies which cannot be included in the investment portfolios and this is shown in Figure 5. It is important to note that the two levels of screening are adopted by most funds but the approach by Bursa Malaysia[3] is not to combine both qualitative and quantitative screening and avoid ratios used by other indices. Bursa Malaysia focuses mainly on the qualitative aspects rather than the quantitative aspects. Hence, it is recommended that NEST follows the majority and this is also recommended by the AAOIFI. With regard to the quantitative analysis, there is a wide spectrum of ratios used by different indices which is shown in Table I. There is the liquidity ratio which aims at eliminating sale of debts. This involves dividing account receivables and cash in hand by either the total assets or market capitalisation. The former (total assets) is deemed to be a more appropriate denominator because it reects the value of the asset of the company and is audited while the latter, i.e. market capitalisation, is difcult to keep track of and its value is often subjected to manipulation by market forces. The ratio interest to total income is an important element to consider because interest is not permissible. However, due to the rule of need and necessity not to deprive Muslim of an asset class of investment, a 5 percent tolerance limit has been allowed by the

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DJIM Alcoholic Beverages Biotechnology (Genectic & Foetus)

FTSE

S&P

MSCI

HSBC

Amiri

DIB*

Azzad

Meezan

48

Broadcasting & Entertainment Conventional financial services Gambling Hotels Insurance Meat Production Media Agencies** Pork-related products Restaurants & Bars Tobacco Trading of Gold & Silver Weapons & Defence

Figure 5. The qualitative screening criteria adopted by some Islamic Share Indices

core business

any involvement

* The sector screens of DIB is defined based on the best of our knowledge * * except newspapers

Source: Derigs and Marzban (2008)

scholars and is acceptable by AAOIFI Standard. The debt to total assets ratio is an important ratio to consider because if the debt is too high, usually when the ratio is more that 30 percent, the fear is that the company is too geared towards debt and the risk to venture in sale of debt when buying the shares is too risky. Islam does not allow the sale of debt except when at par. As far as sukuk is concerned, it is a nascent industry. Legislation is now being developed in the UK and there is not much scope for the time being as there are very few sukuk issued that meets pension fund requirements. However, NEST may look into infrastructure nancing. Habib (2009) conducted a survey in this area and found this to be an expanding market and an obvious area for investment of pension funds. Property market is always in demand despite the hiccups witnessed every now and then. NEST may look into Islamic REITs which still need to be developed in the UK.

DIIM 50 50 70 33 49 45 70 80

FTSE S&P MSCI HSBC Amiri DIB Azzad (%) (%) (%) (%) (%) (%) (%) Meezan (%)

Current market price of the share

5 33 33 33.33 33 33

30 30

Liquidility screens Accounts receivables cash and cash equivalents short term investments) divided by total assets # (50-80 percent) Cash and cash equivalents accounts receivables divided by total assets # (50-80 percent) Accounts receivables (cash and cash equivalents and short term investments) divided by average trailing market capitalisation # (50-80 percent) Accounts receivables divided by average trailing market capitalisation # (50-80 percent) (Current assets minus current liabilities divided by total common shares outstanding # current market price of the share) Interest screens Total interest income/total revenue # 5 percent Cash and cash equivalents short term investments/average trailing market capitalisation # 33 percent Cash and cash equivalents short term investments/total assets # 33 percent Short term investments long term investments / total assets # (30-33 percent) Short term investments long term investments/ average trailing market capitalisation # 30 percent 33

(continued )

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Table I. The various ratios used for quantitative analysis for buying of shares

50

Cash and cash equivalents accounts receivables short term investments long term investments/ total assets # 30 percent Cash and cash equivalents accounts receivables short term investments long term investments/average trailing market capitalisation # 30 percent Debt screen Total debt/total assets # (30-40 percent) Total debt/average trailing market capitalisation # (30-33 percent) Non-permissible income screen Non-permissible income other than interest/total revenue # 5 percent Non-permissible income including 33 33 5 5 5 5 33 33.33 30 33 30 30 33

Notes: Where DJIM Dow Jones Islamic Index Group; FTSE Financial Times Islamic Index Series; S&P Standard and Poor s islamic index Group; MSCI Morgan Stanley Capital International Islamic Index Group; HSBC HSBC Amanah Fund; Amiri Amin Capital Islamic Fund (Pakistan); DIB Dubai Islamic Bank; Azzad Azzad Islamic Fund (USA); Meezan Meezan Islamic Fund (Pakistan) Source: Derigs and Marzban (2008)

Table I. DIIM FTSE S&P MSCI HSBC Amiri DIB Azzad (%) (%) (%) (%) (%) (%) (%) Meezan (%) 30 30 40 5

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Islamic REITs are collective investment vehicles that pool money from investors to buy, manage and sell real estate. The investment is primarily in: . income-producing Shariah compliant real estate, and/or . single purpose companies which are Shariah compliant whose principal assets comprise of Shariah compliant real estate. The incomes from the real estate or companies are used to provide returns to its unit-holders. A portion of the REIT funds can also be invested in other Shariah compliant asset classes, e.g. cash or Shariah acceptable deposits. Islamic REITs also provide a new investment opportunity for investors who wish to invest in real estate through Shariah compliant capital market instruments and is an effective means of gaining investment exposure to large Shariah-compliant commercial properties. Investments in Islamic REITs provide opportunities to hold stakes in high-grade Shariah-compliant real estate which may otherwise have been difcult or impossible for a retail investor to hold. However, there are several issues to be considered when investing in Islamic REITs: . The high distribution of annual prot and lower reinvestment may lead to a slower growth rate. . Although the business tends to be a fairly stable one, REITs are not without risk. For example, their dividend payments are not guaranteed and the real estate market is prone to cyclical downturns. Furthermore, there is a lack of a developed secondary market for Islamic instruments including REITs. . Shariah restrictions might restrict investment universe. . There is no universal Islamic REITs guidance and regulatory framework which is yet to be developed. The Securities Commission in Malaysia has been working on a framework for Islamic REITs which can be adapted or adopted by the British regulator. 4.3 Issues to be addressed by NEST regarding the Shariah fund h While NEST will have to look at the accumulation and decumulation of the sharia fund when it is established, it is not clear whether the money contributed by Muslims will be ring-fenced. This is a crucial issue and NEST has not yet unveiled this in its document. If the fund is supposed to be Shariah compliant, then by absorbing the contribution in the main stream will default the fund as it gets polluted Islamically. Another important point that has to be addressed pertains to the model and structure that will be adopted to establish the fund. As discussed above, if it is going to be a dened contribution, this will then effectively attract interest and gharar, etc. One way of eliminating the issue of interest (riba) and uncertainty (gharar) may be through a takaful fund. There is also a need to consider the contribution as a donation (tabarru) towards the risk fund (pension fund), which is then invested. The underpinning legal mechanism would be the waad (promise) to enforce it and another suggested model could be the wakalah model whereby NEST would act as a wakeel (agent) to manage the fund on behalf of the participants. The issue of law of inheritance need to be addressed. In case a person dies prior to the maturity of the pension plan, then his money ought to go to his Islamic legal heirs

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and not nominees. This is an important but neglected aspect among Muslims having private pension plans. As the lump sum is not the money of the deceased till his/her retirement, he/she does not have a right per se on it. Hence, should he/she die prior to his/her retirement age, then this money goes to his/her estate according to Islamic law. State old age pension or retirement pension has been considered as strong debt (dain al-qawi ) when it is in line with the provident fund concept (Sha, 1995, p. 6). Upon retirement, a worker is entitled to a lump sum. This lump sum is considered in Shariah as part and parcel of his total salary because at the time of starting his job this offer is already made to him as part of his salary package except that this part of the salary (the pension) is delayed. This is why it is considered as a strong debt, i.e. one which can easily be claimed from the government or employer from an Islamic perspective. This is similar to the dened benet concept. However, if one has a choice in the investment, then it does not constitute a salary package and will attract riba and gharar. But in case it is a dened contribution where one knows how much he/she is contributing but is unaware how much he/she will receive, then this is a debatable issue. Some Ulama (religious scholars) argue that it is not permissible. Nowadays, most pension plan favour dened contribution rather than dened benet. The reason being that it is very difcult to predict the longevity risk and the return one can expect from the market to build up the portfolios. So the client is given a choice where he/she wishes to invest in, depending on his/her risk appetite and the level of return he/she hopes to get. The case of NEST is an in-between scenario in that rst, it is a semi-governmental body but it is the employer who opts to invest the contributions with NEST. Hence, it is not really similar to the state pension though the state can intervene. This issue needs some further Fiqhi debate. Another important issue that has to be addressed is the annuity. Buying and selling of annuities is strictly prohibited in Islam because it will attract riba. Usually this is done via an insurance company. NEST has not explained how it will attend to this issue for the Shariah fund. Ultimately this is what matters for Muslim pensioners. It is suggested that the annuity can be underwritten by the government or a choice can be given to the Muslim participants to withdraw their money monthly based on some ceiling, say 5 percent, after their retirement, i.e. their money should be left in the pool after the derisking phase of the investment. This is a very important Fiqhi issue that needs to be resolved as there is no takaful company dealing with this situation in the UK. 4.4 Fiqh issues related to Islamic pension There are a number of qhi issues that demand our attention. First, the money contributed towards the pension fund is technically a saving, which thus attracts zakah (poor due). Hence, it is an important aspect to address because it also affects if a person dies prior to the maturity of his/her retirement. Since the bulk of the assets may be conned to the retirement lump sum, this requires a proper Islamic analysis of wealth management. Since increase in wealth attracts zakah, this entire contribution to the q Shariah fund cannot be only from the individuals perspective but also from the infa sectors (voluntary or philanthropic sector) perspective because the saved money may generate a regular source of nance in the form of zakah on contribution as well as prot earned on investment, which can be used for future development. The second problem is that most asset classes for investment do not comply with Shariah as can be shown in Figure 4. Most investment funds currently invest in haram

(non-permissible) projects which are not a good source of income for Muslims. Thus, there is a need to look for sustainable source of Islamic investment instruments such as sukuk and equity. This is another area needing research because the pension fund will need to be accumulated. The third issue is related to the need to buy an annuity upon maturity of the retirement period and this is usually provided by conventional insurance companies. So far, the issue of annuity has not been resolved and there is room for exploring the possibility of an Islamic pension fund in line with the development of Islamic nance industry. There is currently genuine concern on the sale of pension plans, accumulation of the fund and distribution of the fund from an Islamic perspective, and takaful companies are now looking into it. This creates a new case of research as the risks for the contracts and the investment tools may all be different in the case of an Islamic pension fund. Fourth, the legal and regulatory framework for conventional pension is well established but is not adequate to cater for an Islamic fund. The takaful tabarru concept[4] may be the way forward with NEST acting as a wakeel for a mudharabah fund between the employers and the employees or a waqf model where the beneciaries will only be the employees. 4.5 The proposed model Despite the various qh problems identied earlier, there is a way of overcoming those problems. Figure 6 shows a proposed model based on the concept of tabarru, which is a unilateral contract of donation. Hence it does not attract gharar and riba according to Islamic law. So when the participants make a donation to the fund, that fund becomes the investment fund for developing the pension fund. There are two main phases to consider in developing a pension fund: the accumulation phase and the decumulation phase. The rst phase is the accumulation phase, which aims mainly at investing the donations (tabarru) into long-term investment nancial instruments in order to grow

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Annuities from Investments to participants of pension funds

Participants contribute to pension funds

Pension funds distribution

Investment as form of savings

Zakah as development for security system

Mudharabah projects from zakah

Source: Authors own creation

Figure 6. Proposed Shariah compliant model for NEST Shariah fund

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the fund and not a contribution based on personal account. Another way to accumulate the fund is to come to an agreement with those who will receive their lump sum after retirement, which usually is a consequential amount to pay their zakah on this investment to the fund if it is reinvested with them. This can be used to sustain the poor old workers deserving zakah. Muslim economists have debated the issue of developing a zakah fund to further nance needy people on the basis of mudharabah. This is another way to further accumulate the fund. The next phase is the decumulation phase when the fund depletes to maintain the retirees. The money they received is similar to an annuity but Islamically, it will be done on the basis of tabarru as well. The model proposed is that the fund will promise to pay a tabarru to the participant of the fund upon retirement. This is similar to a Takaful product (Islamic insurance). Again the sum to be given as tabarru can be calculated actuarially. Given the payment is a unilateral contract, the issues of riba and gharar do not arise, compared to buying an annuity whereby a person contractually agrees to pay a sum of money in exchange to be maintained with another sum of money till he dies. This is called a contract of exchange (aqd al-muawadhah) and thus attracts riba and gharar. 5. Conclusion This article described the evolution of pension and the change in the legal nexus between pension providers and employees, and how it may affect the qh dynamism of present day pension funds. Pension started as a philanthropic stratagem to encourage ` -vis authority and to guarantee them a regular workers and soldiers to be loyal vis-a income after their retirement. It later became a political tool and a burden in governmental budget which subsequently results in the need for people to purchase their own pension plans. Due to the increasing number of people who cannot afford to buy their own pension plans and with the ageing population problems, the British government has now initiated NEST as a vehicle to automatically enrol everyone 7,475 to save for their old age and not to rely having a minimum annual salary of E solely on state pension. The NEST Shariah fund is a new challenging development in satisfying Muslims religious demands when they retire. The paper argues in favour of having good Islamic investment strategies and alternatives and highlights the constraints of accumulating the fund. There are still a few jurisprudential issues that need to be resolved and for which some suggestions have been made.
Notes 1. Decumulation is the process of converting the pension fund into more liquid form of assets in order to prepare for the payment of annuities. 2. The 2001 census statistics reveals that 510,000 people were living in medical and care establishments, of which two fths were aged 85 and over. According to a survey conducted 24,700, by Saga, the average cost of a single room in a residential home across the UK was E 35,100 for a single room in a nursing home. 39 percent of the people this gure increases to E are paying these costs themselves, usually from equity in their home. 3. The Bursa Malaysia endorses industries with mix products on the basis of umum al-balwa, i.e. an evil which economy cannot do without such as hotel selling alcohol provided that the limit of alcohol sale does not exceed 25 percent of total income. 4. As premium in conventional insurance contract is not permissible due to the element of riba and gharar, Muslim scholars devised the concept of Tabarru which means donation.

Donation being a unilateral contract does not attract riba and gharar according to Islamic law. So in an Islamic insurance context the clients contribute a donation rather than purchasing a policy. This donation goes to a takaful pool whereby they all joint-guarantee each other in case a specic accident or a risk materialises. References n, Al-Azhar Press, Cairo. Baladhuri, A. (1932), FutE I al-BuldE Blackburn, R. (2002), Banking on Death, or Investing in Life: The History and Future of Pensions, Verso, London. Blake, D. (2003), Pension Schemes and Pension Funds in the United Kingdom, Oxford University Press, Oxford. Blake, D. (2006), Pension Finance, Wiley, West Sussex. Derigs, U. and Marzban, S. (2008), Review and analysis of current Shariah-compliant equity screening practices, International Journal of Islamic and Middle Eastern Finance and Management, Vol. 1 No. 4, pp. 285-303. Granger, T. (2008), Pensions Simplied, Management Books 2000 Ltd, Cirencester. Habib, A. (2009), Islamic Financing for Infrastructure Projects, Dubai International Financial Centre, Dubai. Mayhew, L. (2001), A comparative analysis of the UK pension system including the views of ten pension experts, public participation and pension policy process: citizen and pension reform (PEN-REF Project), Birkbeck College, University of London, London. Numani, S. (1975), Al-Farooq the Life of Omar the Great, Islamic Publsihers, New Delhi. PADA (2009), Building Personal Accounts: Designing an Investment Approach, Key Findings of the Public Consultation, Personal Accounts Delivery Authority, London. Pension Commissions (2004), Pensions: Challenges and Choices. The First Report of the Pensions Commission (Turners Report), TSO Publishing, London. Sha, M. (1995), The Payment of Zakat and Receiving of Interest on Provident Fund, Darul Ishaat, Karachi. Thillainathan, R. (2000), The Employees Provident Fund of Malaysia: Asset Allocation, Investment Strategy and Governance Issues Revisited. World Economic and Social Survey (UN, 2007) (2007), The Development in an Ageing World, United Nations, New York, NY. Zaman, H. (1991), Economic Functions of an Islamic State (The Early Experience), Islamic Foundation, Leicester. Further reading Bell, J. and Sleziak, D. (Eds) (2008), Pensions Law Handbook, Tottel Publishing, West Sussex. Chapra, U. (2008), Muslim Civilisation, the Causes of Decline and the Need for Reform, Islamic Foundation, Markeld. Department of Work and Pension (Flexible) (2007), Retirement & Pension Provision, Consultation Documents, Department of Work and Pension, London. Giesecke, J. and Meagher, G.A. (2009), Population ageing and structural adjustment, General Paper No. g-181, Monash University, Melbourne, January. Ibn Taymiyyah (1982), Public Duties in Islam, Islamic Foundation, Leicester. Lederman, D. (2009), Operating Models for Pension System Reforms, OECD, Paris.

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Leigh, A. (2009), Permanent Income Inequality: Australia, Britain, Germany and the United States Compared, Discussion Paper No. DP 628, The Australian National University, Canberra. Muslim Demographics in UK (n.d.), available at: www.salaam.co.uk/themeofthemonth/ september03_index.php?l2 (accessed 7 March 2010). Nesbitt, S. and Neary, D.L. (2001), Ethnic Minorities and Their Pensions Decisions A Study of Pakistani, Bangladeshi and White Men in Oldham, Joseph Rowntree Foundation, Layerthorpe. Raana, I.M. (1970), Economic System under Umar the Great, SH. Muhammad Ashraf, Lahore. United Nations Department of Economic and Social Affairs (2007), World Economic and Social Survey Development in an Ageing World, United Nations, New York, NY. Usmani, M.S. (1995), Provident Fund, Darul Ishaat, Karachi. Verbit, G.P. (2002), The Origins of the Trust, Xlibris Corporation, Bloomington, IN. About the author Faizal Ahmad Manjoo is a Lecturer in Islamic Finance and Law at the Markeld Institute of Higher Education/Gloucester University in Markeld, Leicestershire, UK. Faizal Ahmad Manjoo can be contacted at: faizalmanjoo@yahoo.co.uk

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